Customer-base concentration, profitability and distress across the corporate life cycle
This paper has been written with Paul Irvine and Shawn Saeyeul Park and has been published at The Accounting Review in 2016. The paper focuses on better understanding an age old question in economics and finance. Is it better to depend on a few, large, well-established customers or should you try to expand your customer base? Both strategies have advantages and disadvantages.
Dealing with a few large customers could lead to more efficient supply chain management and better visibility into future orders. On the other hand an asymmetrically powerful major customer could demand price concessions, leading to significantly smaller gross margins. Whether the advantages or disadvantages of relying on a few major customers dominate is entirely an empirical question.
Using a recently expanded data set on supplier-customer links, we introduce a dynamic relationship life-cycle hypothesis. We hypothesize that the relation between customer-base concentration and profitability is significantly negative in the early years of the relationship, but becomes positive as the relationship matures. The key driver of this dynamic is the customer-specific investments that the relationship entails. These investments result in larger fixed costs, greater operating leverage and a higher probability of losses early in the relationship, but can significantly benefit the firm as the relationship matures. Although many of these money-losing firms in early-stage relationships were not studied in Patatoukas (2012), we find a market reaction to increases in customer concentration similar to that in his paper. This result provides powerful confirmatory evidence of the value of customer concentration. We document one of the intangible benefits of customer concentration, technology sharing, and show how this benefit increases as the relationship matures.
Çelim Yıldızhan, Research & Ideas